Today we’ll look at Yangtzekiang Garment Limited (HKG:294) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Yangtzekiang Garment:
0.008 = HK$9.6m ÷ (HK$1.3b – HK$131m) (Based on the trailing twelve months to September 2018.)
So, Yangtzekiang Garment has an ROCE of 0.8%.
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Does Yangtzekiang Garment Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Yangtzekiang Garment’s ROCE appears to be significantly below the 10.0% average in the Luxury industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Yangtzekiang Garment compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. It is likely that there are more attractive prospects out there.
Our data shows that Yangtzekiang Garment currently has an ROCE of 0.8%, compared to its ROCE of 0.5% 3 years ago. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Yangtzekiang Garment has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Yangtzekiang Garment’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Yangtzekiang Garment has total assets of HK$1.3b and current liabilities of HK$131m. As a result, its current liabilities are equal to approximately 9.8% of its total assets. With barely any current liabilities, there is minimal impact on Yangtzekiang Garment’s admittedly low ROCE.
What We Can Learn From Yangtzekiang Garment’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than Yangtzekiang Garment. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Yangtzekiang Garment better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.